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ESSAYS ON INFLATION, STOCK MARKET AND BORROWING CONSTRAINTS
by
Hüseyin Günay
A Dissertation Presented to the
FACULTY OF THE USC GRADUATE SCHOOL
UNIVERSITY OF SOUTHERN CALIFORNIA
In Partial Fulfillment of the
Requirements for the Degree
DOCTOR OF PHILOSOPHY
(ECONOMICS)
August 2010
Copyright 2010 Hüseyin Günay

In this dissertation, firstly I model the relation between the stock market and inflation, and provide empirical evidence of my theory in the US equity market. The second chapter has international evidence of effects of inflation on the equity markets for the G7 countries. In the third chapter, I look at the effects of business cycle fluctuations on the equity market and explain them through the credit channel via borrowing constraints on different sectors in a developing country.; Both recent and previous research mentioned the relationship among inflation, stock return and dividend yield (or price to earnings ratio). These papers empirically show that there is a positive correlation between dividend yield and inflation, and a negative link between expected inflation and stock returns. Nevertheless, these properties had not been used for modelling asset prices up to now. I model the relation between inflation and stock prices from a standard asset pricing model stand point by introducing nominal prices for a share of stock. Furthermore, by introducing heterogeneity among agents in terms of inflation expectations, the model investigates the implications of having differences among the agents on the stocks. Using the model provided, it is shown that heterogeneity in inflation expectations can cause undervaluation or overvaluation in the stock market resulting in predicted returns to be positive or negative, respectively. These predictions are corroborated by the results of the empirical study on the United States equity market. Results do not only show that stock returns are on average negatively affected by expected inflation on average but also that the effect is reversed during high inflationary periods, in accordance with the predictions of the model. The second chapter of this dissertation presents a similar panel regression study on a group of developed countries; Canada, France, Germany, Italy, Japan, the United Kingdom and the United States, the so called G7 countries. International empirical study also yields results comparable to the US study in the first chapter.; The capital market imperfections have important consequences for aggregate cycles, especially for financially developing countries. The research on the relation between imperfections and output dynamics at the macro level are ample, but the lack of wide coverage micro data sets for developing countries limit the study of aggregate implications of the micro level capital market imperfections. The final part of my dissertation first documents the boom-bust cycles in Turkey and shows that non-tradable sector is more volatile over the business cycles than tradable sector. Moreover, this sector based asymmetry is strongly correlated with aggregate credit movements. To establish the connection between the sector based asymmetries and the credit markets further, secondly it constructs two micro data sets. Using structural estimation, the study finds that non-tradable sector is financially more constrained than tradable sector. With non-tradable sector being more constrained, credit movements become an important determinant of boom-bust cycles. Therefore, it can be established that the asymmetry in the financial constraints of the different sectors at the micro level can generate the observed asymmetrical aggregate response of sectors over the business cycle.

ESSAYS ON INFLATION, STOCK MARKET AND BORROWING CONSTRAINTS
by
Hüseyin Günay
A Dissertation Presented to the
FACULTY OF THE USC GRADUATE SCHOOL
UNIVERSITY OF SOUTHERN CALIFORNIA
In Partial Fulfillment of the
Requirements for the Degree
DOCTOR OF PHILOSOPHY
(ECONOMICS)
August 2010
Copyright 2010 Hüseyin Günay